Here is what matrimonial lawyers and their clients need to know about the substantial tax and economic benefits of the CARES Act.
By John E. Johansen, Tax and Valuation Expert
The $2 trillion stimulus bill, known as the CARES Act (the “Coronavirus Aid, Relief, and Economic Security” Act), was signed into law on March 27th with the goal of addressing the economic and industry impacts of the COVID-19 pandemic. It includes tax relief, grants, and loan assistance. Not only will the provisions of this Act affect divorce settlements in 2020, but the effects will also need to be understood and addressed by family lawyers for several years into the future. Here are how the key provisions of the act will affect these settlements.
The CARES Act: Two Primary Loan Programs
The CARES Act created two primary loan programs:
- the Paycheck Protection Program (PPP); and
- the Economic Injury Disaster Loan (EIDL).
The PPP is primarily designed to cover the costs of keeping employees on the payroll while the business is closed. It is designed to be a forgivable loan if 75% of the funds are used to pay eight weeks of payroll costs (wages up to $100K, health insurance and retirement plan contributions); 25% of the funds can be used to pay rent, mortgage interest, and utilities. The forgiven loan is not taxable.
If the funds are used for other business expenses and therefore not forgiven, PPP is a two-year loan at 1% interest with a six-month deferral period on repayment but not on the accrual of interest. This program was initially funded with $350 billion and the funds were totally distributed in less than two weeks. As of the writing of this article, there has been a second round of funding approved and an additional $321 billion in funding is in the process of being distributed to businesses.
EIDL, the second loan program funded as part of the CARES Act, offers working capital loans for payroll, accounts payable, and other bills, as well as fixed debts that could have been paid had the disaster not occurred. The loans are made only to small businesses with fewer than 500 employees and can be for up to $2 million. The repayment term is 30 years at 3.75% with a 12-month deferral period on repayment but not of the accrual of interest. This program also ran out of funding, but as I write this, there also has been a second round of funding approved and an additional $60 billion has begun flowing to businesses.
These programs are not only important to family lawyers trying to settle cases in 2020 but also in future years when they are looking at their client’s or their client’s spouse’s business cash flow. The business valuation experts the lawyers hire to assist them will need to make adjustments to the financial statements of these businesses for the above programs – especially for the forgivable portion of PPP.
The CARES Act Created Substantial Changes to the Tax Code
The two loan programs are not the only ways for businesses and individuals to receive much-needed cash flow – the CARES Act also made substantial changes to the tax code that can be utilized to produce immediate cash.
The first of these allows employers to defer their 6.2% share of the social security tax otherwise required to be made from March 27 through the end of the year; half of the deferred amount is due 12/31/21 and the other half on 12/31/22. Self-employed individuals can defer payment of up to 50% of their SECA tax.
Special rules apply to employers that receive PPP loans. They may defer deposit and payment of their share of Social Security tax, without penalty, through the date that the lender issues a decision to forgive the loan. Once an employer receives that decision, the employer is no longer eligible for the payroll tax deferral on an ongoing basis. However, the amount that was previously deferred will continue to be deferred through the end of 2021 and 2022.
In addition to the deferral of the employer portion of the 6.2% Social Security tax, there is the Employee Retention Credit. This credit is not allowed to be combined with the above deferral or by an employer taking a small business interruption loan (PPP or EIDL), so it is important for the employer and their CPA to prepare an analysis of which program produces the greatest benefit for them. The Employee Retention Credit applies to employers who are at risk of closure due to COVID-19; they can receive a payroll tax credit against eligible payroll taxes for each quarter equal to 50% of the qualified wages paid to each employee.
The credit is available for an employer whose operations were fully or partially suspended due to a COVID-19 related shut-down order from an appropriate governmental authority or if gross receipts declined by more than 50% when compared to the same quarter in the prior year. The eligible wages for an employee are up to $10,000 for all calendar quarters. Qualified wages include wages and health benefits paid to an eligible employee. Since the credit is 50% of up to $10,000 of eligible wages, it could be worth $5,000 in tax credits per employee, which can be applied to all payroll taxes – including the employer and employee share of Social Security and Medicare taxes, as well as Federal Withholding taxes.
3 Changes to the Tax Cuts and Jobs Act (TCJA)
Three changes to the TCJA affecting businesses are temporarily eased and can be carried back to prior years to reduce taxes in those years, thereby producing refunds. These refunds can be requested for quick refund by filing a Form #1045 or Form #1139.
The first is that Net Operating Losses (NOLs) generated in 2018, 2019, and 2020 can be carried back five years; normally these losses could only be carried forward and would not be eligible to be applied to prior years. This means that if a business had a loss in 2018 or 2019 and is currently carrying it forward, they can file amended returns and apply it to the profitable years that they had in the last five years, reducing taxes and generating refunds of taxes paid in those years. Additionally, a NOL normally could only be applied to 80% of taxable income; for purposes of the five-year carryback, the 80% limitation does not apply. The NOL changes will also apply to NOLs generated in 2020 – and there are sure to be many.
The two additional business tax changes that can be applied to prior years by amending returns and thereby produce refunds are:
- The limit for deducting business interest on business debt is increased for 2019 & 2020 from 30% of adjustable taxable income to 50% of ATI.
- The cap on the deduction for business losses on individual returns is suspended for 2018 through 2020.
Prior to this change, the amount of trade or business losses over $500K for couples and $250K for single taxpayers was nondeductible with any excess carried forward.
A Welcome Correction to the TCJA Could Produce The Biggest Refunds
A key technical correction to the TCJA could produce the biggest refunds of all the changes created by CARES. The correction involves depreciation for restaurant, retail, and leasehold remodeling, known as Qualified Improvement Property. Under the 2017 Act, this property was meant to be given a 15-year life, making it eligible for 100% bonus depreciation; unfortunately, this did not happen, and businesses have been stuck taking these expenses over a 39-year period.
Now, businesses can amend their tax returns for 2018 and 2019 and take 100% of the cost of these capital improvements as an expense – thereby reducing taxable income or even potentially producing NOLs that could be carried back for five years. This change could be the life preserver that restaurants, retail stores, and other businesses need right now to stay in business.
4 Retirement-Related Easings for 2020
The CARES Act also includes four key retirement-related easings for 2020.
1. Individuals can skip taking their required minimum distributions from IRAs and employer plans.
2. The 10% penalty on pre-59.5 payouts from retirement accounts is waived on up to 100K of Coronavirus related payouts.
3. Funds repaid within three years are treated as tax-free rollover distributions; otherwise, tax is spread over three years.
4. Eligible individuals can borrow up to $100K from workplace plans – such as 401K plans – and repayments on retirement plan loans due in 2020 are delayed for one year.
The CARES Act: a Complex Tax Environment Becomes More Complex
As you can see, an already complex tax environment just became more complex. Family lawyers are going to need to be familiar with these concepts – but now more than ever, they need to have a strong relationship with an experienced CPA who understands the above as well as how the CARES Act will affect business valuations going forward.
John E. Johansen (CPA, ABV, CFP, MBA) has been part of the tax, accounting, and financial planning industry for over 25 years. Together with his team of professionals, he specializes in working with individuals and closely-held businesses in implementing tax minimization strategies. www.tax-first.com
WATCH: What Family Lawyers Should Know About the CARES Act
Manhattan tax and financial expert John Johansen discusses the CARES Act – including loan plans, tax incentives, and how it could affect business valuation during divorce – with Family Lawyer Magazine’s Editorial Director, Diana Shepherd.